Deck 23: Options

Question 1

At expiration a call option will have no value if the stock price is less than exercise price.

Answer 1

True

Question 2

The value of both call and put options increases as the variability of the stock price decreases.

Answer 2

False

Question 3

At expiration a put option will have no value if the stock price is less than the exercise price.

Answer 3

False

Question 4

A call option is worthless if the underlying stock is worthless.

Question 5

Warrants do not expire.

Question 6

Stock price volatility is beneficial to option holders.

Question 7

Only at the expiration date can an investor expect to find the value of call options above their lower bound.

Question 8

The seller of a put option is betting that the market value of the stock will decrease.

Question 9

Convertible bonds give the investor the option to buy the firm's stock in exchange for the value of the underlying bond.

Question 10

A callable bond gives the issuer a potentially valuable option in the case of changing interest rates.

Question 11

Unlike call options, the option to abandon a real asset project does not become more valuable as time to expiration increases.

Question 12

The Financial Accounting Standards Board (FASB) requires that companies recognize the fact that employee stock options are valuable and therefore are an expense just like salaries and wages.

Question 13

The VIX is an estimate of expected future market volatility over the next 30 calendar days.

Question 14

The longer the time until expiration of a call option, the lower the value of the option.

Question 15

Callable bonds give the call option to the issuing firm and hence reduce the value of the bond.

Question 16

Put-call parity holds only if an investor plans to hold the options to maturity.

Question 17

Callable bonds allow the investor to redeem the bond at face value or let the bond remain outstanding until maturity.

Question 18

The price of a call option increases as the exercise price decreases.

Question 19

The Financial Accounting Standards Board (FASB) stipulates that companies must use an option valuation model to estimate the fair value of any option grants and then deduct this value when calculating profits.

Question 20

The lower limit on a call option's value is equal to the greater of zero or the exercise price minus the stock price.

Question 21

What is the option buyer's total profit or loss per share if a call option is purchased for a $5 premium, has a $50 exercise price, and the stock is valued at $53 at expiration?

A) -$5
B) -$2
C) $3
D)$8

Question 22

Which one of the following is true for an investor who purchased a share of stock for $45 and purchased a $45 put option on the stock?

A) The investor profits when the stock decreases in value.
B) The maximum loss is the price of the option premium.
C) The investor is protected against upside potential.
D)Increases in the value of the stock will go to the seller of the put.

Question 23

A writer of a call option expects the stock price to:

A) decrease.
B) increase.
C) split.
D)produce quarterly cash dividends.

Question 24

The value of a call option increases as the strike price increases.

Question 25

A callable bond will have a lower value than a straight bond with the same coupon rate and maturity.

Question 26

What is the difference between an American call option and a European call option?

A) The European call has a final exercise date.
B) The American call trades only on domestic stocks.
C) The European call can be exercised only on one day.
D)The American call generates profits regardless of which direction the stock moves.

Question 27

Warrants are long-term call options on a company's stock issued by an organized stock exchange.

Question 28

Which one of the following is true for the owner of a call option?

A) The loss potential is unlimited.
B) The profit potential is unlimited.
C) The premium exceeds the strike price.
D)There is no expiration date, unless the option is a European call.

Question 29

When the stock price is very high compared to the exercise price, the call option premium approximates the difference between the stock price and the present value of the strike price.

Question 30

The floor of a convertible bond will be the value of the underlying bond.

Question 31

What is the profit per share for an investor who has purchased a share of stock for $42 and purchased a put option with an exercise price of $40 and a premium of $2 if the stock was valued at $30 at expiration?

A) $6
B) -$6
C) -$4
D)$4

Question 32

A warrant is a long-term call option that is "in the money" at the time of issuance.

Question 33

Which combination of positions will tend to protect the owner from downside risk?

A) Buy the stock and buy a call option
B) Sell the stock and buy a call option
C) Buy the stock and buy a put option
D)Buy the stock and sell a put option

Question 34

An increase in which one of the following will decrease the value of a call option?

A) Interest rate
B) Time to expiration
C) Volatility of stock price
D)Exercise price

Question 35

A protective put is a costless way of eliminating the downside risk of holding stock.

Question 36

Adding warrants as a "sweetener" to bonds will:

A) reduce the value of the bond.
B) increase the coupon rate of the bond.
C) increase the value of the bond.
D)make the bond riskier.

Question 37

Which one of the following option traders receive the option premium?

A) Option sellers
B) Option buyers
C) Both option sellers and buyers
D)Neither buyers nor sellers receive premiums

Question 38

Calculate the profit per share for an investor that exercises a put option with a strike price of $60 when the stock is selling for $46 and the premium for the put option was $4.

A) -$14
B) -$10
C) $10
D)$18

Question 39

The value of a convertible bond is always less than the value of a straight bond with similar coupon and maturity.

Question 40

If the owner of a call option with a strike price of $35 finds the stock to be trading for $42 at expiration, then the option:

A) expires worthless.
B) will not be exercised.
C) is worth $7 per share.
D)cost too much initially.

Question 41

If a $1,000 convertible bond has a conversion ratio of 50 and the firm's equity is currently selling for $22 per share, then the:

A) bond should trade for $900.
B) bond should trade for $1,000.
C) bond should trade for $1,100.
D)firm will have already converted the bond.

Question 42

Investors who hold warrants essentially have a:

A) put option on the firm's bonds.
B) put option on the firm's equity.
C) call option on the firm's bonds.
D)call option on the firm's equity.

Question 43

Stock options have been traded on exchanges since:

A) the founding of the New York Stock Exchange.
B) options were created in 1946.
C) the early part of the 1970s.
D)just before the stock market crash in 1987.

Question 44

A stock is currently selling for $70 per share and its call option has an exercise price of $90. What is the lower limit on the value of the call option?

A) -$20
B) $0
C) $10
D)$20

Question 45

Which one of the following conditions will typically be present when a firm calls a bond prior to maturity?

A) The firm is in poor financial health.
B) Interest rates have risen substantially since the bond was issued.
C) Interest rates have fallen substantially since the bond was issued.
D)The call option is ready to expire.

Question 46

What is the worst-case profitability scenario for an investor who sold a call on the firm's stock for a premium of $10 and a strike price of $100?

A) $90 per share profit
B) $10 per share profit
C) $0 per share profit
D)Unlimited losses

Question 47

The major difference between options on real assets and options on financial assets is that options on:

A) financial assets are costly.
B) financial assets have a higher probability of positive payoff.
C) real assets are implicit, rather than explicit.
D)real assets are not influenced by price volatility.

Question 48

The value of a callable bond equals the value of a straight bond:

A) plus the value of the bondholder's call option.
B) minus the value of the bondholder's call option.
C) plus the value of the issuer's call option.
D)minus the value of the issuer's call option.

Question 49

Executive stock options are issued with the hope that the recipient will:

A) sell the shares they currently own thereby diversifying the firm's ownership.
B) work to increase the value of the firm's stock.
C) never execute them.
D)sell their shares at the option's exercise price.

Question 50

The option to abandon a project investing in real assets can be considered to have a strike price equal to the:

A) historical cost of the asset.
B) market value of the asset at abandonment.
C) foregone revenues anticipated from the project.
D)foregone interest on the bonds used to finance the real assets.

Question 51

Why is the value of a call option said to increase as the interest rate increases?

A) The stock seller must pay the call owner more interest.
B) The present value of the strike price is reduced.
C) As interest rates increase, stock prices increase.
D)Interest rate increases reduce the option premium.

Question 52

Owning a call option that has a high probability of being exercised is said to be almost equivalent to owning the stock. In which way is owning a call not equivalent to owning the stock?

A) Option holders pay no income taxes.
B) Stockholders do not have capped (restricted) profits.
C) Option holders do not receive dividends.
D)Stockholders cannot sustain losses.

Question 53

Which one of the following call options would command the higher premium, other things equal? (All months are within the same calendar year.)

A) October expiration, $45 strike price
B) December expiration, $40 strike price
C) March expiration, $45 strike price
D)June expiration, $40 strike price

Question 54

Which one of the following statements is correct?

A) A convertible bond will be priced less than a similar callable bond.
B) A convertible bond will be priced more than a similar callable bond.
C) Similar callable and convertible bonds will have the same price.
D)Warrants are always priced more than convertible bonds.

Question 55

The conversion ratio for a convertible bond equals the:

A) number of interest payments that must be received prior to conversion.
B) number of bonds necessary to convert into one share of stock.
C) number of shares of stock that can be exchanged for one bond.
D)floor value beneath which the bond price cannot fall.

Question 56

How much must the stock be worth at expiration in order for a call holder to break even if the exercise price is $50 and the call premium was $4?

A) $46
B) $50
C) $52
D)$54

Question 57

If a $1,000 convertible bond with a market value of $950 has a conversion ratio of 25 when the firm's stock is selling for $36 per share, then:

A) the bond will be converted immediately.
B) the bond is violating its price floor.
C) conversion now would give the investor a profit of $900.
D)the conversion value of the bond is $900.

Question 58

If you feel strongly that a stock price will move, but are unsure of the direction, you could buy the stock and:

A) buy both a put and a call.
B) sell both a put and a call.
C) buy a put and sell a call.
D)buy two puts.

Question 59

What is the value of a convertible bond with a conversion ratio of 25, face value of $1,000, coupon rate of 10%, and yield to maturity of 10%? Common stock of this firm is currently selling at $35.

A) $875
B) $1,000
C) $1,125
D)$1,875

Question 60

A decrease in which one of the following terms will cause an increase in the call value of an option?

A) Interest rates
B) Time to maturity
C) Exercise price
D)Volatility of the stock

Question 61

Jennifer sold a call option on XXX Corp. with an exercise price of $50 and a premium of $3. The option expires today and XXX is currently trading at $40. What is Jennifer's expected profit or loss per share?

A) -$3
B) $3
C) $7
D)$10

Question 62

At what point on the graph of possible values for a call option does the buyer break even financially?

A) When the stock price equals the strike price
B) At any point on the upward-sloping segment of the graph
C) When the stock price equals the cost of the option plus the strike price
D)At the point where the graph intercepts the y-axis

Question 63

Which one of the following is correct for the owner of a September put, valued at $20, on CBA Corp. with a strike price of $80? CBA currently trades at $67.

A) The option will continue to gain value until its September expiration.
B) The owner profits $13 per share by exercising now.
C) Further decreases in the CBA stock price will be translated directly into additional option value.
D)$20 is the maximum value for this option.

Question 64

The payoffs from investing in an option contract are designed so that:

A) both the buyer and the seller of the contract will profit.
B) the seller's (buyer's) gain is the buyer's (seller's) loss.
C) roughly 20% of sellers and 50% of buyers profit.
D)there are no profits but there are also no losses.

Question 65

A share of stock is currently priced at $20 and will change with equal likelihood to either $55 or $15. A call option with a $25 exercise price is available on the stock. You want to borrow funds to purchase the stock in order to replicate the call option. How many shares of stock must be purchased to replicate one call option?

A) 1.33 shares
B) 0.75 share
C) 0.80 share
D)1.25 shares

Question 66

A call option will have the highest value when the stock price is:

A) far above the strike price.
B) closest to the strike price.
C) approaching zero.
D)less than the strike price.

Question 67

Of the following four put options that can be purchased on a stock, which would you expect to have the highest price? (All option months are in the same calendar year.)

A) September put; $65 exercise price
B) September put; $75 exercise price
C) December put; $65 exercise price
D)December put; $75 exercise price

Question 68

Firms spend an increasing amount of time evaluating real options, which are:

A) options on real assets such as an option to abandon.
B) call and put options traded on organized exchanges.
C) call options such as warrants and convertible bonds.
D)put options such as those held by shareholders of a firm with financial leverage.

Question 69

Which one of the following is correct for the owner of a June call, valued at $3, on XYZ Corp. with a strike price of $60? XYZ Corp. currently trades at $55.

A) XYZ stock will go to $63 per share within the option period.
B) The option should be exercised now.
C) The option owner's current profit is $3 per share.
D)The option may expire without value.

Question 70

It has been determined that 0.5 share of stock should be purchased with borrowed funds to replicate the payoff to one call option. What is the option's strike price if the stock could range in value from $110 to $10 at the expiration of the option?

A) $40
B) $50
C) $60
D)$70

Question 71

It is May 19 and you own a June European call on ABC Corp. with an exercise price of $50. The option trades at $40 and ABC is trading at $86. What should you do?

A) Exercise the option now and take the profits.
B) Buy more options on ABC Corp.
C) Sell your ABC stock before its price declines.
D)Sit and wait until the June expiration.

Question 72

Calculate the return on exercising a put option that was purchased for $10, with an exercise price of $85. The stock price at expiration is $81.

A) -60%
B) 60%
C) 30%
D)-30%

Question 73

The buyer of a put option has a(n) _____ to sell the underlying asset and the option seller has a(n) ____ to buy the underlying asset.

A) obligation; obligation
B) obligation; right
C) right; right
D)right; obligation

Question 74

Under what circumstance will the buyer of a put option be asked to fulfill her obligation?

A) When the stock price has declined below the strike price
B) When the stock price has increased above the strike price
C) The put buyer has an equal obligation regardless of the relationship between stock and strike prices.
D)The put buyer has no obligation whatsoever.

Question 75

When does a change in the value of a call option come the closest to matching the price change in a share of stock?

A) When the stock is priced far above the strike price
B) When the stock is priced far below the strike price
C) When the stock is priced near zero
D)Changes in call value always come close to matching changes in stock price.

Question 76

Which one of the following statements is correct for an investor who has purchased portfolio insurance by owning a stock and buying a put option on that stock?

A) The investor profits when the stock price declines.
B) Maximum profitability occurs when the stock price equals the strike price.
C) Value per share can decline no further than the strike price less the value of the option premium.
D)The option will certainly be exercised.

Question 77

At what point is the payoff from owning a call option on a stock greater than the payoff from owning the stock itself?

A) When stock price exceeds strike price at expiration
B) When strike price exceeds stock price at expiration
C) When stock price equals strike price at expiration
D)Call payoff never exceeds stock payoff.

Question 78

Joe sold a put option on ZZZ Corp. with an exercise price of $40 and a premium of $4. The option expires tomorrow and ZZZ is currently trading at $28 per share. What will be Joe's profit or loss per share if the option is exercised tomorrow and the price remains the same?

A) -$16
B) -$8
C) $8
D)$16

Question 79

The value of a call option increases as the time to expiration increases because:

A) the exercise price continually decreases.
B) the opportunity increases for the stock price to surpass the exercise price.
C) the dividends accumulate while waiting to be paid.
D)the option can be repeatedly exercised.

Question 80

Stocks that have more volatile price changes have more valuable call options because call holders:

A) capture upside potential without downside risk.
B) realize that volatility decreases the present value of the exercise price.
C) have too little variability in the exercise price.
D)have transferred all risk to put holders.